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Location, Location, Location

Most investors are familiar with the term “asset allocation,” which describes the overall composition of one’s investment portfolio: how their funds are spread among various asset classes and categories. Often expressed in percentage terms and baked in a pie chart (see below), asset allocation is one of the key metrics by which investors and their advisors judge the efficacy of their portfolios in light of their objectives. It is a critical piece of prudent investment management.

However, fewer investors pay the same level of attention to asset location, which can be every bit as important as asset allocation. Whereas asset allocation describes how you are invested (what investments you own, and what percentage you have allocated to each of your holdings), asset location describes where your investments are situated (what types of investment vehicles and accounts they are held in, and the ownership structure of those accounts).

At a high level, asset allocation is helpful in determining how diversified your portfolio is, and what sort of risk-adjusted returns can be expected. On the other hand, asset location is helpful in determining:

  1. The tax-efficiency of your accounts,
  2. Whether your assets are sufficiently protected from creditors, and
  3. How liquid/accessible your assets are.

To illustrate the importance of asset location, and to keep things simple, let’s compare two basic account types that will be familiar to most readers: pre-tax retirement plans (IRAs, 401ks, etc.), and taxable brokerage accounts. The two charts that follow outline a few of the pros and cons of each account type (location) within the three categories listed above (taxation, asset protection, and liquidity/accessibility):

As these charts demonstrate, financial planning is not "simply" a matter of picking the right investments. It also involves picking the right account types and investment vehicles to house those investments. This is particularly important for wealthy investors, whose higher levels of taxable income and net worth call for more sophisticated tax, asset protection, and liquidity planning. Taxes, creditors, and lack of liquidity can undermine a plan just as swiftly and soundly as a bad investment - sometimes worse.

So remember: Investing, like real estate, is all about location, location, location!

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Like everyone else, I have been following the tragic events in Ukraine with a combination of dismay, sorrow, and frustration. But stories like these - of life and love - give me hope.